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I think the way we do options in startups needs a more fundamental rethink. I wouldn't be too sad if the current system falls on its face. I like Buffett's pro

I think the way we do options in startups needs a more fundamental rethink. I wouldn't be too sad if the current system falls on its face. I like Buffett's proposal from a few years ago. They don't grant stock, they simply pay cash (bonuses) and if employees want to buy in, it's their money, after all. What's really needed is a way some group of insiders in a company can transfer shares among themselves or outsiders. This would probably take a big change in securities laws to create rules around how unaudited equities could be traded. But I keep seeing these stories about AMT, employees leaving who never vest, golden handcuffs, etc., it makes me think we need to make private company stock work more like public company stock, somehow. Another thought: Zuckerberg has said a few times he doesn't think going public was as bad as people said it would be. Maybe the solution is for companies to become public earlier and have investors operate more like PIPE shops or activists who just hold big chunks of company stock?

austenallred 9y ago
That’s the point of options though - most of the time that “cash” doesn’t exist to be paid out in bonuses. Options are a bet that it will exist in the future. Why do startups pay lower salaries than Facebook? Because Facebook throws around $200-300k salaries and doesn’t care. Startups can’t do that, so it promises a piece of the pie if the company becomes big and successful instead.
- mooreds 9y ago
  Nor does the ability to "buy in" exist for normal employees unless the business is public or sets up some kind of ESOP.
- eldavido 9y ago
  I don't think this is true anymore. I think this is one of those funny vestigial things that evolved in a different era. If you think of a startup as a true "garage venture" with a few people toiling away trying to ship a product, maybe that's the right model. That isn't really the model for SV entrepreneurship anymore, though, even though we kinda pretend it is. How it works today is, $8 million-dollar "seed" rounds, downtown office space, early-stage companies paying $150k or more for talent, incubators and signaling, etc. Maybe one of those cases where the game has changed, but our mythos hasn't.
  - mooreds 9y ago
    Maybe this is true in SV. My experience in other areas of the country is that startups, especially early stage ones, don't have that kind of cash.
  - austenallred 9y ago
    That’s simply incorrect. I founded a company that raised a mammoth seed round in Silicon Valley (not $8m but more than $3m), and we do pay some high salaries, but Apple and Facebook still pay salaries that are much, much higher. Critical employees have joined us while taking $100,000/yr pay cuts, despite. Having a salary in the six figures. To think that startups can play that game of “equity doesn’t matter” is just wrong, even in an era of $8m seed rounds. I know HN likes to say “go for cash not stock,” which is a good way to negotiate if you want to avoid downside risk, but if you eliminate stock compensation there’s no way startups can play ball with incumbents. Full stop.
    - pascalxus 9y ago
      I don't think so. Why should employees make up such a large percentage of the money invested in the company? When you take a salary cut of 50K, it's like taking that money an investing it right then and there. Why should an employee be investing 50K of their own money into the company every single year? It's bad enough that someone would invest 50K in a single company: one that picked them, not the other way around, with all the information asymmetries that applies, but to add insult to injury: the risk is compounded by the fact that their investing all this money into the very same company they depend on for their paycheck. VCs are much much better equipped to do investing: both in terms of skill sets, experience and information. Employees should not be forced to become angel investors just because they work at a start up. VCs will always have enough money to invest in truely excellent opportunities. It just means, they'll need to invest more. And in this low interest rate world, I don't think the world is starving for cash is it?
      - austenallred 9y ago
        Maybe an employee believes in the company and wants to take part, deeming the risk is worth it for them? Clearly that's what's happening. It's certainly rational in some cases to take the risk of owning a portion of a company instead of taking the same amount of cash and putting it in the S&P 500. You're always investing your time and money, it's just a matter of where. And for what it's worth, if you're getting paid $250k at Apple, you can probably go back at almost any time.
- oneshot908 9y ago
  At this point, unless you're C-suite, most startups are a really bad bet compared to the BigCos paying out anywhere from $250K-$1M annually depending on your skill set and experience. What's happening now IMO is that the hot talent has figured this out and they have accepted positions at Tesla, Salesforce, Google, Facebook, Apple, or Amazon. That said, I know someone who walked away from a $10M package over 4 years to be the CTO of his startup. I wouldn't have, but everyone has to follow their path, right?
  - austenallred 9y ago
    It all depends. It’s certainly hard to compete with a $500k/yr sure thing, but personally I’d rather have a $150k/yr salary with a chance to retire if the company does well than a sure $200k/yr. It just all depends. Risk-adjusted, the best way to get returns is probably to take an equity-heavy stake at a post-series-B startup with obvious growth and product market fit.
    - optimuspaul 9y ago
      I used to feel that way too until I tried it multiple times. All of the startups I've been involved with have been buried or purchased with deals that made my options worthless or effectively worthless (i.e. needing to come up with enough capital to execute the options for such a meager gains that it was hardly worth the effort).
      - austenallred 9y ago
        On the other hand I know hundreds of people that this kind of equity made millionaires.
  - 3pt14159 9y ago
    The other problem is cryptocurrencies have created a ton of new companies that are paying big for talent. I actually think this is a good thing. Too many people were working on dumb startups back then. I want more engineers at Tesla.
- s73ver_ 9y ago
  Yeah, but all the risk of that bet is put on the employee. The employer faces none of it.
conanbatt 9y ago
The main problem i see with the equity system is that its absolutely intransparent in terms of cap tables and preferred shares. To the very least, if companies were forced to give out cap tables, or at least, a calculator that gives you your payout based on the company sell out cases, you would be able to measure it. Right now, the calculation is complicated and obsfucated for employees. Lets say you have 1% of stock and the company sells at 100m. You are most likely not going to get 1m because of preferred shares. Preferred shares are truly a cancer on the system.
- walshemj 9y ago
  Or like in the uk for approved (ie tax friendly) enforce the issuing of the same shares to employees as the others.
  - conanbatt 9y ago
    I'm not sure that is better. Extra provisions on capital might be adding more capital to the mix, which increase wages all around. It might be shooting yourself in the foot. But hiding the information is a way for investors to have more leverage over employees. That is an undoubtedly unfair surplus to them. Its not the only thing I'd change. I would do away with the restriccions of investing in startups as well. That would allow employees to buy stock whenever they want to (and the company is willing to sell them for) without this obscure negotiation. The minimum limits on investing in startups is a way to give higher returns to investors, while harming founders and employees.
    - walshemj 9y ago
      Why its to stop some shareholders being taken advantage of by companies with different share classes.
      - conanbatt 9y ago
        I think that effect is somewhat overrated. In the end, its best to let people get what they want. In that sense, not having information doesnt let people choose what they want. Limiting what can be offered is more likely to prevent people from being able to get what they want. Its possible that investors are very risk averse and so, are willing to pay a big premium for the preferred shares, one that employees are not willing to pay. In that case, employees actually win out on the deal, as they might not be as risk averse (as its only a small part of the compensation). But in that game, the employee is barred from buying unlimitedly (min 1mm in assets) and also from knowing what everyone else is getting (which investors know). I cant emphasize how big a loss it is to not let employees invest. Employees know a lot of things investors don't and share that information amongst each other, but can't give market signals because they cant buy or sell or disclose freely. I.E. if you saw a company where employees are all buying shares now, its great for both employees and the general public AND investing in general. Not only that, but not being able to sell and exchange shares between employees means you cant hedge bets as employee. For example, you could pool a bunch of startup shares that way. Thats only for investor groups today. Sometimes when I think the US is supposed to be the pinnacle of economic liberalism, I shed a few tears.
maerF0x0 9y ago
>What's really needed is a way some group of insiders in a company can transfer shares among themselves or outsiders. This would probably take a big change in securities laws to create rules around how unaudited equities could be traded. Most option/stock agreements give the company right of refusal and they can block sales >They don't grant stock, they simply pay cash (bonuses) and if employees want to buy in, it's their money Doesnt work for private companies, there's no market to buy them in > Maybe the solution is for companies to become public earlier and have investors operate I've recently been thinking about the ramifications of more and more of our economy being privately traded. It means that many groups of people are unable to use that slice of the economy to back things like retirement funds. Also can technically lead to a run on equity where folks are trying to save but are just competing over the same limited pool of assets. Articles like [1] are indicating that the number of IPOs per year are dwindling. Maybe a law that says companies valued over $THRESHOLD must be public? [1]: http://fortune.com/2017/01/20/public-companies-ipo-financial-markets/ http://fortune.com/2017/01/20/public-companies-ipo-financial...
- kelnos 9y ago
  >> They don't grant stock, they simply pay cash (bonuses) and if employees want to buy in, it's their money > Doesnt work for private companies, there's no market to buy them in Personally I'd like to see more employee profit-sharing arrangements. Difficult for a lot of companies though that run at a loss for years.
johnhess 9y ago
Link to Buffett's proposal?
- eldavido 9y ago
  It's from the 2016 earnings letter. He was making a completely different argument, namely, that accounting that ignores options expense is bullshit (many companies still present this separately in their earnings reports). The relevant section is as follows: "To say “stock-based compensation” is not an expense is even more cavalier. CEOs who go down that road are, in effect, saying to shareholders, “If you pay me a bundle in options or restricted stock, don’t worry about its effect on earnings. I’ll ‘adjust’ it away.” To explore this maneuver further, join me for a moment in a visit to a make-believe accounting laboratory whose sole mission is to juice Berkshire’s reported earnings. Imaginative technicians await us, eager to show their stuff. Listen carefully while I tell these enablers that stock-based compensation usually comprises at least 20% of total compensation for the top three or four executives at most large companies. Pay attention, too, as I explain that Berkshire has several hundred such executives at its subsidiaries and pays them similar amounts, but uses only cash to do so. I further confess that, lacking imagination, I have counted all of these payments to Berkshire’s executives as an expense. My accounting minions suppress a giggle and immediately point out that 20% of what is paid these Berkshire managers is tantamount to “cash paid in lieu of stock-based compensation” and is therefore not a “true” expense. So – presto! – Berkshire, too, can have “adjusted” earnings." Full pdf: http://www.berkshirehathaway.com/letters/2016ltr.pdf http://www.berkshirehathaway.com/letters/2016ltr.pdf I guess the difference is that big scaled companies have revenues, and cash, whereas small companies don't. But I don't think that's so true anymore in a time when companies are doing nine-figure investment rounds. I'm not saying it's typical, but I do think this model of "bundled options+cash" has got to go.

austenallred 9y ago

That’s the point of options though - most of the time that “cash” doesn’t exist to be paid out in bonuses. Options are a bet that it will exist in the future. Why do startups pay lower salaries than Facebook? Because Facebook throws around $200-300k salaries and doesn’t care. Startups can’t do that, so it promises a piece of the pie if the company becomes big and successful instead.

mooreds 9y ago
Nor does the ability to "buy in" exist for normal employees unless the business is public or sets up some kind of ESOP.
eldavido 9y ago
I don't think this is true anymore. I think this is one of those funny vestigial things that evolved in a different era. If you think of a startup as a true "garage venture" with a few people toiling away trying to ship a product, maybe that's the right model. That isn't really the model for SV entrepreneurship anymore, though, even though we kinda pretend it is. How it works today is, $8 million-dollar "seed" rounds, downtown office space, early-stage companies paying $150k or more for talent, incubators and signaling, etc. Maybe one of those cases where the game has changed, but our mythos hasn't.
- mooreds 9y ago
  Maybe this is true in SV. My experience in other areas of the country is that startups, especially early stage ones, don't have that kind of cash.
- austenallred 9y ago
  That’s simply incorrect. I founded a company that raised a mammoth seed round in Silicon Valley (not $8m but more than $3m), and we do pay some high salaries, but Apple and Facebook still pay salaries that are much, much higher. Critical employees have joined us while taking $100,000/yr pay cuts, despite. Having a salary in the six figures. To think that startups can play that game of “equity doesn’t matter” is just wrong, even in an era of $8m seed rounds. I know HN likes to say “go for cash not stock,” which is a good way to negotiate if you want to avoid downside risk, but if you eliminate stock compensation there’s no way startups can play ball with incumbents. Full stop.
  - pascalxus 9y ago
    I don't think so. Why should employees make up such a large percentage of the money invested in the company? When you take a salary cut of 50K, it's like taking that money an investing it right then and there. Why should an employee be investing 50K of their own money into the company every single year? It's bad enough that someone would invest 50K in a single company: one that picked them, not the other way around, with all the information asymmetries that applies, but to add insult to injury: the risk is compounded by the fact that their investing all this money into the very same company they depend on for their paycheck. VCs are much much better equipped to do investing: both in terms of skill sets, experience and information. Employees should not be forced to become angel investors just because they work at a start up. VCs will always have enough money to invest in truely excellent opportunities. It just means, they'll need to invest more. And in this low interest rate world, I don't think the world is starving for cash is it?
    - austenallred 9y ago
      Maybe an employee believes in the company and wants to take part, deeming the risk is worth it for them? Clearly that's what's happening. It's certainly rational in some cases to take the risk of owning a portion of a company instead of taking the same amount of cash and putting it in the S&P 500. You're always investing your time and money, it's just a matter of where. And for what it's worth, if you're getting paid $250k at Apple, you can probably go back at almost any time.
oneshot908 9y ago
At this point, unless you're C-suite, most startups are a really bad bet compared to the BigCos paying out anywhere from $250K-$1M annually depending on your skill set and experience. What's happening now IMO is that the hot talent has figured this out and they have accepted positions at Tesla, Salesforce, Google, Facebook, Apple, or Amazon. That said, I know someone who walked away from a $10M package over 4 years to be the CTO of his startup. I wouldn't have, but everyone has to follow their path, right?
- austenallred 9y ago
  It all depends. It’s certainly hard to compete with a $500k/yr sure thing, but personally I’d rather have a $150k/yr salary with a chance to retire if the company does well than a sure $200k/yr. It just all depends. Risk-adjusted, the best way to get returns is probably to take an equity-heavy stake at a post-series-B startup with obvious growth and product market fit.
  - optimuspaul 9y ago
    I used to feel that way too until I tried it multiple times. All of the startups I've been involved with have been buried or purchased with deals that made my options worthless or effectively worthless (i.e. needing to come up with enough capital to execute the options for such a meager gains that it was hardly worth the effort).
    - austenallred 9y ago
      On the other hand I know hundreds of people that this kind of equity made millionaires.
- 3pt14159 9y ago
  The other problem is cryptocurrencies have created a ton of new companies that are paying big for talent. I actually think this is a good thing. Too many people were working on dumb startups back then. I want more engineers at Tesla.
s73ver_ 9y ago
Yeah, but all the risk of that bet is put on the employee. The employer faces none of it.

conanbatt 9y ago

The main problem i see with the equity system is that its absolutely intransparent in terms of cap tables and preferred shares. To the very least, if companies were forced to give out cap tables, or at least, a calculator that gives you your payout based on the company sell out cases, you would be able to measure it. Right now, the calculation is complicated and obsfucated for employees. Lets say you have 1% of stock and the company sells at 100m. You are most likely not going to get 1m because of preferred shares. Preferred shares are truly a cancer on the system.

walshemj 9y ago
Or like in the uk for approved (ie tax friendly) enforce the issuing of the same shares to employees as the others.
- conanbatt 9y ago
  I'm not sure that is better. Extra provisions on capital might be adding more capital to the mix, which increase wages all around. It might be shooting yourself in the foot. But hiding the information is a way for investors to have more leverage over employees. That is an undoubtedly unfair surplus to them. Its not the only thing I'd change. I would do away with the restriccions of investing in startups as well. That would allow employees to buy stock whenever they want to (and the company is willing to sell them for) without this obscure negotiation. The minimum limits on investing in startups is a way to give higher returns to investors, while harming founders and employees.
  - walshemj 9y ago
    Why its to stop some shareholders being taken advantage of by companies with different share classes.
    - conanbatt 9y ago
      I think that effect is somewhat overrated. In the end, its best to let people get what they want. In that sense, not having information doesnt let people choose what they want. Limiting what can be offered is more likely to prevent people from being able to get what they want. Its possible that investors are very risk averse and so, are willing to pay a big premium for the preferred shares, one that employees are not willing to pay. In that case, employees actually win out on the deal, as they might not be as risk averse (as its only a small part of the compensation). But in that game, the employee is barred from buying unlimitedly (min 1mm in assets) and also from knowing what everyone else is getting (which investors know). I cant emphasize how big a loss it is to not let employees invest. Employees know a lot of things investors don't and share that information amongst each other, but can't give market signals because they cant buy or sell or disclose freely. I.E. if you saw a company where employees are all buying shares now, its great for both employees and the general public AND investing in general. Not only that, but not being able to sell and exchange shares between employees means you cant hedge bets as employee. For example, you could pool a bunch of startup shares that way. Thats only for investor groups today. Sometimes when I think the US is supposed to be the pinnacle of economic liberalism, I shed a few tears.

maerF0x0 9y ago

>What's really needed is a way some group of insiders in a company can transfer shares among themselves or outsiders. This would probably take a big change in securities laws to create rules around how unaudited equities could be traded. Most option/stock agreements give the company right of refusal and they can block sales >They don't grant stock, they simply pay cash (bonuses) and if employees want to buy in, it's their money Doesnt work for private companies, there's no market to buy them in > Maybe the solution is for companies to become public earlier and have investors operate I've recently been thinking about the ramifications of more and more of our economy being privately traded. It means that many groups of people are unable to use that slice of the economy to back things like retirement funds. Also can technically lead to a run on equity where folks are trying to save but are just competing over the same limited pool of assets. Articles like [1] are indicating that the number of IPOs per year are dwindling. Maybe a law that says companies valued over $THRESHOLD must be public? [1]: http://fortune.com/2017/01/20/public-companies-ipo-financial-markets/ http://fortune.com/2017/01/20/public-companies-ipo-financial...

kelnos 9y ago
>> They don't grant stock, they simply pay cash (bonuses) and if employees want to buy in, it's their money > Doesnt work for private companies, there's no market to buy them in Personally I'd like to see more employee profit-sharing arrangements. Difficult for a lot of companies though that run at a loss for years.

johnhess 9y ago

Link to Buffett's proposal?

eldavido 9y ago
It's from the 2016 earnings letter. He was making a completely different argument, namely, that accounting that ignores options expense is bullshit (many companies still present this separately in their earnings reports). The relevant section is as follows: "To say “stock-based compensation” is not an expense is even more cavalier. CEOs who go down that road are, in effect, saying to shareholders, “If you pay me a bundle in options or restricted stock, don’t worry about its effect on earnings. I’ll ‘adjust’ it away.” To explore this maneuver further, join me for a moment in a visit to a make-believe accounting laboratory whose sole mission is to juice Berkshire’s reported earnings. Imaginative technicians await us, eager to show their stuff. Listen carefully while I tell these enablers that stock-based compensation usually comprises at least 20% of total compensation for the top three or four executives at most large companies. Pay attention, too, as I explain that Berkshire has several hundred such executives at its subsidiaries and pays them similar amounts, but uses only cash to do so. I further confess that, lacking imagination, I have counted all of these payments to Berkshire’s executives as an expense. My accounting minions suppress a giggle and immediately point out that 20% of what is paid these Berkshire managers is tantamount to “cash paid in lieu of stock-based compensation” and is therefore not a “true” expense. So – presto! – Berkshire, too, can have “adjusted” earnings." Full pdf: http://www.berkshirehathaway.com/letters/2016ltr.pdf http://www.berkshirehathaway.com/letters/2016ltr.pdf I guess the difference is that big scaled companies have revenues, and cash, whereas small companies don't. But I don't think that's so true anymore in a time when companies are doing nine-figure investment rounds. I'm not saying it's typical, but I do think this model of "bundled options+cash" has got to go.